The kind of attention the Chinese yuan gets is fascinating. At the height of the debt ceiling nonsense and the subsequent days, the yuan surged to a record high against the $US, and made some of the largest moves on record. Countless reports told stories that it signaled Beijing’s ambitions for internationalisation, or the use of the exchange rate as a monetary policy tool, or Beijing’s increasing dislike of the $US. Whatever. Of course, in the subsequent days and weeks, the yuan has not been doing much against the $US, and the stories have faded.
Let’s get this straight: first off, if something is allegedly “undervalued” and has been rising from the “lows”, that thing is bound to make record high after record high. Second, we all know that Chinese policy makers make things happen at a pace that they think is appropriate, so you never know where we’ll end up. Think of the so-called “through-train” arrangement for Hong Kong shares in 2007: it was so hyped that boosted that Hong Kong stocks flew to the heaven, only to fall back to hell as it turned out to be a mere blank cheque.
The latest Bloomberg report which suggests that Yuan will be convertible by 2015 is yet another example of the sort of thing that has to be taken with caution. First of all, there are still 4 years in between. Second, nobody knows what policy makers will be thinking about even tomorrow, let alone 2015 (and we will have new Chinese leaders as well).
The problem here is that even though the growth of the Chinese economy is now probably relying less on exports, it’s still a big chunk of the Chinese economy, and the export sector is now struggling, thus it’s hard to see why Chinese policy makers would be happy to allow a Chinese yuan float (if that means the yuan will appreciate substantially, which is not entirely certain). And for the yuan to be fully convertible, it will require policy makers to take away capital controls.
Take a step back and consider the Chinese economy today. It relied on foreign demand for its exports, and foreign capital for its investment. As a result, the Chinese economy has been running a chronic current account surplus as well as capital account surplus (do note that the capital controls in China mean the capital can go into the country more easily than getting out), and the soft currency peg, if you like, forces China to print money and accumulate foreign exchange reserve, helping China to produce all sorts of liquidity. That’s how the country funds its investment-led growth.
Whether and when the yuan will float depends on whether the government judges it to be good for the Chinese economy (whatever it means). For one thing, floating its currency and making it fully convertible removes the need to create so much money and accumulate foreign exchange reserves. But that money creation is what it needs to fuel the investment-led growth model, and floating the currency will most probably put an abrupt end to that.
Don’t get me wrong. I am not saying that the yuan will never be fully convertible. I am also not saying that the yuan has no chance to be a new reserve currency. No one knows how things are exactly going to unfold. You can say what you like, but I wouldn’t believe any so-called “commitment”.
And by the way, the PBOC governor Zhou Xiaochuan just denied there is any defined schedule for convertibility.